November 2018Lebanon Seems to Have Fallen Victim to the ‘Presource Curse’

A recent World Bank paper by James Cust and David Mihalyi argues that the “curse” befalling states which discover and extract petroleum may in fact be leveled before revenues reach a state’s coffers. They argue that once a discovery is made—often in anticipation of oil revenues—politicians are inclined to increase spending through borrowing that endangers macroeconomic stability and reduces growth. This is particularly the case in countries with weak institutions where politicians’ actions are left unchecked. The authors coined the term “presource curse” to describe such phenomena and build on the well-established concept of a resource curse, which associates oil revenues with lower growth, higher poverty and corruption, and fewer “democratic practices”.

In reaction to this paper, I was recently invited by the Lebanese Oil and Gas Initiative to discuss whether Lebanon is pre-ordained to succumb to a presource curse. Although Lebanon has yet to make a discovery, it has issued two exploration and production licenses to one consortium led by Total S.A. I argued that Lebanon is not only pre-ordained to fall subject to a presource curse but also that Lebanon is already experiencing a pre-presource curse. To be precise, even before an oil discovery has been made, politicians were active in increasing spending through borrowing and dividing the spoils that have consequently undermined macroeconomic stability since the end of the civil war. They have systematically undermined fiscal discipline by increasing spending on public wages as a result of largely overstaffing the bureaucracy with their clients; contracting public projects with little transparency and accountability by largely dismissing the procurement process; and issuing treasury bills to close the gap between revenues and spending, often at higher interest rates than necessary. Not only have expenditures risen at a high rate since the 1990s, inefficiency in the use of resources has worsened as Lebanon uses 25% and 13% more input to produce the same health and education outcomes, respectively. Such irresponsible fiscal policies led to a high chronic deficit to GDP of about 13% from 1992 to 2016, which is much higher than the 3% average of MENA countries and 2.5% average for countries worldwide with similar levels of development as Lebanon. Consequently, debt to GDP has reached almost 160%, one of the highest in the world.

This was not always the case in Lebanese public finance. In fact, from 1944 to 1958, Lebanon had high budget surpluses. Even during the period of Chehabism, when state institutions were created to assume more responsibilities, Lebanon’s public finance had moderate surpluses of 2% to 3% to GDP from 1958 to 1970. The rise of chronic deficits—and consequently public debt—is a relatively recent development, which is largely associated with the political settlement that ended years of civil strife. Specifically, the change in the balance of power brought about by the Taef Agreement—which resulted in different political institutions being controlled by various confessional groups—institutionalized a new dawn of fiscal mismanagement. The political elite saw in the new arrangement—which manifested itself in the Troika of the 1990s and the different constellation of power sharing since 2005—the possibility to extract state resources that are beneficial to them at the expense of Lebanon’s citizens. While this kept the peace, it came at a high economic and fiscal cost.

Prior to the civil war period, Lebanon had the formal and informal mechanisms to constrain spending. That is not to say that Lebanon was corruption-free but the public finance management was more effectively controlled by the executive authority, which was entrusted to the president and not to the Council of Ministers as it has been in the post-war period.

It is within this context that one needs to evaluate the role of a Sovereign Wealth Fund (SWF). While there is extensive talk about its institutional design—including its role and where it should be housed—this may not be useful when seen from the broader mismanagement of public finances. Even if Lebanon adopts an SWF with strong fiscal rules to limit politicians’ temptations to tap into it, such rules will likely be skirted or violated given the broader political and institutional context.

To avoid falling further into the abyss, Lebanon must reconfigure its institutions so they can impose fiscal discipline and prevent ineffective spending by dampening politicians’ temptations to personally capitalize at the expense of the state. The first step toward doing so is bringing public finances in order, by adopting a comprehensive budget according to which all spending is consolidated (i.e., bringing CDR and other agencies’ budgets together), ensuring that public projects are subject to a transparent and competitive procurement process, assessing the effectiveness of spending, and ensuring that any borrowing is being financed at competitive interest rates.

Although these actions are necessary, they are not sufficient. The fundamental issue is ensuring that checks and balances are in place to limit excessive spending. This requires oversight agencies and institutions to play a key role in ensuring fiscal discipline. The Court of Accounts must be empowered to oversee budget spending. The procurement department, which has overseen only 10% of public projects, must have the independence to manage the contracting of all public projects.

The parliament has a key role to play. It must assume its responsibilities—both legislative and oversight— bestowed upon it by virtue of the Taef Agreement rather than rubber stamp the work of the executive. It must oversee the state’s public finances, force the government to pass budget laws, refuse to agree on spending that is not part of the budget, and evaluate government efficiency and effectiveness in spending. In addition to the above, the government, if serious, could establish other institutional arrangements to ensure that fiscal discipline is imposed.

The big question is: Are the political elite, who have divided political power among different confessional groups, able to self-regulate themselves and avoid the temptations of spending oil revenues or borrowing against the forthcoming proceeds? If history is any indication, they have failed to do so. The concern is that these elites will be further tempted by the oil bonanza, which will allow them to further entrench their interests in the system and indefinitely delay any serious reform.